15. Desai Industries is analyzing an average risk project, and the following dat

Question

15. Desai Industries is analyzing an average risk project, and the following data have been developed.
Unit sales will be constant, but the sales price should increase with inflation. Fixed costs will also be
constant, but variable costs should rise with inflation. The project should last for 3 years, it will be
depreciated on a straight line basis, and there will be no salvage value. This is just one of many projects
for the firm, so any losses can be used to offset gains on other firm projects. What is the project's NPV?
WACC 14.00%
Net investment cost (depreciable basis) $200,000.00
Units sold 50,000
Average price per unit, Year 1 $25.00
Fixed operating costs excluding depreciation (constant) $150,000.00
Variable operating costs/unit, Year 1 $20.20
Expected inflation rate per year 5.00%
Marginal tax rate 40.00%

Explanation / Answer

Sales = 50000* $25 = $12,50,000

Variable cost = 50000*$20.20 = 10,10,000

2 nd year = $10,10,000 *(1+1.05)^1= $10,60,500

3rd year = $10,10,000 *(1+1.05)^2 = $11,13,525

Deprerciation = $2,00,000/3 = $66,666.67

Year 0 1 2 3 Net Investment -$2,00,000.00 Sales $12,50,000.00 $12,50,000.00 $12,50,000.00 Less Variable cost $10,10,000.00 $10,60,500.00 $11,13,525.00 Contribution Margin $2,40,000.00 $1,89,500.00 $1,36,475.00 Less Fixed cost $1,50,000.00 $1,50,000.00 $1,50,000.00 Gross profit $90,000.00 $39,500.00 -$13,525.00 Less Dep $66,666.67 $66,666.67 $66,666.67 EBIT $23,333.33 -$27,166.67 -$80,191.67 Less Tax@.40 $9,333.33 -$10,866.67 -$32,076.67 EAT $14,000.00 -$16,300.00 -$48,115.00 Add Dep $66,666.67 $66,666.67 $66,666.67 Net Cash Flow -$2,00,000.00 $80,666.67 $50,366.67 $18,551.67 PV @ .14 $1.00 $0.88 $0.77 $0.67 PV -$2,00,000.00 $70,760.23 $38,755.51 $12,521.85 NPV -$77,962.40

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